The Winners And Losers 2002
Philip Gotthelf
A 2002 review is relatively simple. Stocks were down, bonds and notes were up, real estate held on, and gold made an impressive rally. However, identifying winners and losers is not as easy. For those who held on to optimism that equities would turn around, there are more tax write-offs. Individuals who plunged into government paper saw a rise in principle values, but a decline to anemic yields. Real estate has offered some stability and a rising market, but progress has been based upon declining mortgage rates that most believe have reached their bottom. Thus, exposure in commercial and residential properties has been precipitously rising.
While I would like to boast that commodities offered a definitive alternative to traditional investments, it has been a volatile year with considerable exposure. We were able to tap profits in meats, grains, interest rates, energy, and gold. Yet, the number of false starts and premature stop-outs were painful and extremely frustrating. Still, commodity trading provided exceptional returns for those who sustained the trials and tribulations.
According to The Wall Street Journal, we have returned to the dire performances of the mid-1970's. Blue Chips experienced their worst decline since 1977 while other performances date back to 1974. This is particularly interesting because the U.S. real estate market collapsed in 1974 after a significant boom from 1968 through 1972. In fact, the first real estate investment trusts (REITs) were established as the greatest investment invention since... something. By 1975, Chase Manhattan Bank was scrambling to control the bleeding. I am intimately familiar with those times since my sister was involved in their workout department. New York residential values fell by 60 percent to 75 percent. A property that was worth $150,000 could not be sold for $50,000. The malaise spread to all major metropolitan areas.
As I remember the past, The Wall Street Journal published its own 2002 "Year-End Review" that featured worries over real estate. The headline that real estate may soon return to earth is hardly encouraging for those who have poured money into property while it was orbiting. The conclusion is shared with my warnings during the summer that low mortgage rates could
only go so far. Subscribers should recall my analysis that low rates encouraged over extension. Now, unrelated carrying costs are on the rise. Not the least of which are real estate taxes and maintenance.
So last year's winner in real estate could easily become this year's victim. In particular, rising interest rates could immediately crash property because many new mortgages are variable... for now. The enticing adjustable rate mortgage (ARM) provides a flexible introductory low rate for the first few years... from 1 to 5. Then, the rate is fixed at the current market. Many
property owners are not fully aware of the magnitude of a 1 percent rise in their mortgage rates. The fact is that 1 percent may be the beginning. Some believe the Fed will be forced to bump rates up 2 percent to 3 percent if inflation accelerates during the second half of 2003.
Where Are We On The Curve?
A reconstituted expression has resurfaced among economists. "Where are we on the curve?" This is a cyclical question pertaining to the current position on the recessionary or recovery swing. What does the chart reveal?
For the four years from 1999 through part of 2002, the Dow Industrial Average was in a wide trading range from 10,000 to 11,500. This action was not apparent on a day-to-day or even month-to-month basis because volatility created significant "micro trends." I use this description because daily charts reveal substantial swings that are equivalent to entire yearly ranges in the previous two decades.
Regardless of the percentage game played by analysts and statisticians, the fact is that stock market volatility surpassed the most speculative commodity futures positions in history. The only exceptions were the stock indices themselves!
I believe anyone with reasonable eyesight and cognitive skills can recognize that something changed from 1995 forward. The speculative frenzy increased the trend line slope to an unprecedented angle. The 3-1/2-year culmination also represents unique behavior in comparison with prior decades. By the same token, the crash after busting below 10000 support also displays unprecedented behavior. In many ways, the loss of value exceeds the magnitude of 1929.
The broader S&P 500 displays a more dramatic monthly formation with a symmetrical triangle showing 900 support. The brief bust below 900 warns that this index remains extremely fragile. Another test below 800 paves the way for a dip to 650.
According to many analysts, recessions fade within four to seven years. Yet, this is based upon previous data that do not reflect the same volatility as the late 1990's. In short, no one really knows what to expect. The rules have changed. If we add some fundamentals, P/E ratios remain dubiously high relative to historical averages. A return to "normal" ratios would plunge
equity indices to unbearable levels. Assuming we follow the trend line from 1988 to 1995, the 2003 S&P intersect is 700.
Even with an improvement in corporate earnings, there is little historical justification for present P/E ratios. Unless we have experienced a structural change in equity valuation, prospects for a speculative recovery are not promising... all things remaining equal.
On the other hand, Uncle Sam or Cousin Bush have some unused tools in the chest. For one, Congress has not addressed Social Security privatization. A 10 percent diversion of payroll taxes (FICA) could provide the boost stocks need to reverse the present technical pattern. Removing double taxation would immediately improve dividend payouts that, in turn, would definitely change the valuation formula. Understand that if a higher dividend were paid because there was no tax on the excess corporate earnings, the P/E would be altered. Alternatively and more probably, dividends would not be taxed after receipt which would make the effective yield rise.
What About Inflation?
One of the intriguing 2003 questions is whether we will experience renewed inflation. This leads to the inevitable query, "Are we better off today than we were back when?" Washington and the Department of Labor have been wrestling with the Consumer Price Index (CPI) for more than two decades. Back in 1988, Bush 41 hotly debated changing the CPI to properly reflect a more modern and realistic basket of consumer goods and services. Certainly, the current CPI does not take into account such items as Internet, computing, telephone, entertainment, and new services. There remains an emphasis upon tobacco and bacon. Ratios for home expenses and the breakdowns are ancient. After 30 years of inflation, corn, soybeans, rice, oats, and other grain prices have actually deflated. Beef, pork, poultry, and dairy have remained in relatively narrow trading ranges. Even energy has maintained reasonable long-term stability.
Examine the monthly crude oil chart above. Notice that the range has predominantly been between 1600 and 2600 since 1986. Regardless of spike and troughs, energy costs are not exhibiting a rising secular trend as would be indicated by a trend line. Gasoline and heating oil reflect similar patterns. Given the history, it should be obvious that our obsession with quarterly
numbers that are adjusted for energy and food make sense. Those volatile components are, in reality, non-inflationary.
A look at soybeans over a similar period reveals a subtle decline in tops with a solid baseline. Again, this is not indicative of inflation. There is no secular trend line. In contrast, there have been steady increases in cigarettes, durable goods, tolls, rents, and property. The price of a long distance phone call has plunged from more than 25¢ a minute to as little as 4.9¢. A cell
phone is free with service and minutes are a disposable commodity on weekends!
A good porterhouse steak is about the same today as it was in 1979. Notice the monthly live cattle chart. This shows a beautiful cyclical pattern coupled with seasonal spikes. Even with the cyclical pattern, we can see that the range has remained under $1. Cattle vacillates between 5500 and 9000.
When taking an overall price index into account, we see that inflation reflects the decrease in dollar purchasing parity. Those commodities that do not exhibit a secular uptrend have actually deflated. The price range reflects temporary supply or demand dislocation, but not inflation.
The Golden Question
If we have experienced three decades of inflation, there should be a secular trend in gold that reflects the decrease in dollar purchasing parity. Of course, we know that gold has deflated from highs achieved in 1979/1980. The spike attributed to the inflation/stagflation cycle of the 1970's represents a confidence crisis precipitated by a silver manipulation. Lest we forget, the Hunt brothers wanted silver to become the monetary standard as faith in the Greenback waned. The Hunt's OPEC connection provided support for the alleged market squeeze until Saudi Arabia backed away at the last minute. The manipulation collapsed and precious metals never achieved the same lofty levels with the exception of palladium two years ago.
In contrast against other charts, gold's monthly displays a downward secular trend. So, what's with the inflation connection. Some may argue that inflation has been subdued over the past three years... maybe four. But, this chart dates back to 1980 when gold peaked. Shouldn't there be a rising "inflationary trend."
This is where the conspiracy theorists claim governments have purposely manipulated gold values by selling central bank hoards. This paranoia fails to recognize a significant rise in gold production in conjunction with central bank divestiture. Moreover, gold may actually reflect true purchasing power parity. In other words, gold automatically takes into consideration the stability of food and energy while also adjusting for lower computing, communicating, and entertainment costs.
Indeed, our modern economic formulae are becoming increasingly complex and non-traditional. A point of interest is the pop above gold's upper trend line. For the first time in a long while, gold is reflecting a change in market sentiment. Are we about to face another confidence crisis as we did in 1979? Or, is this simply a temporary aberration based upon uncertainty about Iraq, oil prices, and the U.S. Dollar?
January 6, 2003
Philip Gotthelf
Commodity Futures Forecast
P.O. Box 566, Closter, New Jersey
201-784-1235
www.commodex.com
Presented by:
CONSENSUS, Inc.
P.O. Box 520526
Independence MO 64052-0526
816-373-3700
Fax: 816-373-3701
editor@consensus-inc.com
www.consensus-inc.com
Email this Article to a Friend 
Printer Friendly Version
